Domestic Equity Research Articles

Capital Flows, Asset Prices and Output in Emerging Market Economies

In this article we construct a simple open-economy macro model to examine how capital flows, monetary policy and dividend policies of firms influence asset prices, economic activity and inflation. In this model, we consider a three-asset framework based on domestic money, domestic equity and foreign bonds under flexible exchange rate. The model is based on the assumptions of imperfect asset substitutability and absence of sterilization. The model also incorporates an aggregate supply function in the presence of wage indexation. The model can apply to a large class of emerging market economies which have embarked on a programme of liberalization of the financial sector in general and stock market in particular.

On the Managerial Skills of Mutual Fund Managers (Manipulation-Proof Performance Measure)

The on-going debate over whether fund managers have skills and whether those skills are short-lived is still inconclusive. Using the performance measure that can’t be manipulated with respect to the underlying distribution, time variation, nor estimation error, (the manipulation-proof performance measure (MPPM, Goetzmann et al. (2007)), we rank all U.S. domestic equity mutual funds from 1980 to 2013 on a quarterly basis and analyze their portfolio holdings to generate few insights. First, fund managers in the higher ranked MPPM deciles persistently outperform lower ranked managers by posting higher gross and net fund returns, higher holding-based returns, and generating positive return gap. Second, the characteristic of the holdings indicates higher ranked fund managers would hold younger, smaller, growth, and particularly stocks with lower liquidity and higher information asymmetry. Based on the five-factor (Fama and French (2014)) analysis, our results show that higher ranked managers could generate 15 to 29 basis points while lower ranked managers would loss 20 to 26 basis points on their risk-adjusted ex-post monthly holding returns (alphas) based on their ex-ante constructed holdings. Fourth, the differences on managers of the highest rank and the lowest rank result in monthly risk-adjusted returns (alphas) up to 49 to 52 basis points. Even though the managerial skills are identified at the higher ranked managers, the persistent and the predictability of their superior holding-based returns and fund returns are merely limited to up to six months. We conclude that even though higher ranked managers have better stock picking skills, their net fund returns are not large enough to offset their expenses to warrant positive alphas.

Effectiveness of earnings forecasts in efficient global portfolio construction

We analyze the effectiveness of using fundamental variables of earnings forecasts for constructing mean–variance efficient portfolios. The performances of the Markowitz mean–variance optimal portfolios are examined by selecting stocks based on the consensus temporary earnings forecasts (CTEF) data. An empirical analysis on both US domestic equities and international equities is conducted for the period 1997–2010, and we find that the CTEF variable is a statistically significant factor in generating portfolios with active returns over benchmark portfolios.

Implications of manager replacement: evidence from the Spanish mutual fund industry

We analyse the financial consequences of manager replacement in a sample that includes all domestic and European equity funds in Spain. Specifically, we examine a total of 104 funds of the sample that experience manager turnover over the period 1999–2009. We find that underperforming funds in the pre-replacement period experience a significant improvement in the excess returns and performance after the manager change, an improvement that lasts over time for domestic equity funds. The analysis of the risk profile indicates that funds experiencing a manager change do not show significantly different levels of risk before the replacement dates although they tend to show an increase in the level of total risk after the change. Finally, the pool-regression analysis of the investment flows confirms that manager changes tend to impact negatively on subsequent flows of those funds with manager turnover.

Practical Applications of Inflation Hedging with International Equities

Portfolio managers seeking to hedge the domestic inflation threats posed by quantitative easing may find that international equities are their best bet. In <b><i>Inflation Hedging with International Equities</i></b>, author <b>Maximillian Rödel</b>, Head of Demand and Inventory at <b>Swarovski</b>, investigates the potential benefits of the approach. He studies inflation hedging across different times, countries and levels of equity investibility. Rödel finds that the use of international equities to hedge inflation works best in those countries that experience inflation shocks and possess a weak currency. And in monetarily stable countries, the strategy works least well—perhaps even worse than the use of domestic equities. <b>TOPICS:</b>Portfolio theory, financial crises and financial market history, in markets

Are agribusiness stocks an investor safe haven?

Purpose – The purpose of this paper is to determine how an index of agribusiness stocks performs relative to the S&amp;P 500 particularly in times of recession. Design/methodology/approach – Using value-weighted indexes of agribusiness stocks, large cap US stocks, and copula estimation, the paper quantifies the correlation in potential investment portfolios. The information obtained from the copula estimated dependence measures and Value at Risk (VaR) allows to examine the diversification benefits of holding agribusiness stocks in the portfolio relative to the S&amp;P 500. Findings – The results provide limited evidence that the addition of agribusiness stocks to a portfolio are able to provide significant diversification benefits to a portfolio of domestic equities, as represented by the S&amp;P 500 index. The VaR analysis also indicates the risk of extreme losses remained relatively stable both across time and portfolio weightings. Research limitations/implications – While this research examines a broad-based agribusiness stock index, there exists a number of sub-assets classes within the analyzed index that should be analyzed to see if the offer benefits to investors. In addition, only stocks traded on US-based stock indexes are included in this analysis; as such, the authors would like to extend the research to have a more global approach. Practical implications – The findings suggest that investors who are looking to a broad-based agribusiness stock index to provide more diversification in their portfolio, may find it unattractive from a both a risk management and profit maximizing perspective. However, that does not mean that the agribusiness stock index might be an affective complement to a portfolio that contains multiple other assets classes. Originality/value – The issue of correlation convergence during financial crises is one of great concern to investors. To the authors’ knowledge, this is the first paper that uses copulas to evaluate the role of agribusiness stocks in an investor's portfolio.

Foreign Shocks on Chilean Financial Markets: Spillovers and Comovements Between Bond and Equity Markets

:The domestic impact of external shocks will depend on the degree of coupling of domestic assets to foreign markets, but also on the spillovers among assets. The covariance between different types of assets could be affected by new information. Changes in the covariance, for example, could come from a stronger rebalancing between stocks and bonds. Therefore, we will analyze four different assets-government bonds, corporate bonds, money market instruments, and equities-and study the conditional correlation between them. We find that the corporate bond market tends to increase coupling in turbulent times, while the money market decreases coupling. We propose to test international spillovers taking into account a methodology for estimating the conditional mean, variance, and covariance on domestic bond and equity markets, while considering that shocks may have asymmetric effects depending on whether the news is good or bad.

Aggregate net flows, inflows, and outflows of equity funds: The U.S. versus Japan

This paper investigates the aggregate cash inflows and outflows of domestic equity mutual funds as well as their net flows for the U.S. and Japan in an international context. The U.S. and Japan are two representative countries that have the largest and most developed fund markets in the Western world and Asia, respectively. For the purpose of analyzing dynamic relationships between market volatility, market return, and cash flow, this paper employs reduced-form and structural vector auto-regression (VAR) models. The analysis shows much different empirical findings between the U.S. and Japan, which can be explained by different culture and investment sentiments.

Portfolio performance and risk-based assessment of the PORTRAIT tool

In this paper we evaluate and extend the PORTRAIT tool. PORTRAIT applies an argumentation based methodology for composing fund portfolios. Argumentation allows for combining different contexts and preferences in a way that can be optimized. It allows for defining a set of different investment policy scenarios and supports the investor/portfolio manager in composing efficient portfolios that meet her/his profile. The performance and risk of the constructed portfolios is compared with portfolios based on a traditional performance index under different scenarios. This approach is applied on data of Greek domestic equity mutual funds over the period from January 2006 to December 2011 with positive results. The empirical results of our study showed that argumentation is well suited for this type of applications giving answers to two important questions, i.e. which mutual funds are the most suitable to invest in, and, what portion of the available capital should be invested in each of these funds.

Estimating Changing Significance of Determinants of FII Flows to India Over Different Time Periods in a Vector Autoregressive Framework Using Daily Data

This paper aims at exploring the causal relationship between net foreign institutional investment flows to the Indian equity market with its possible covariates based on daily data for the period September 2008 to July 2013. The data has been analyzed in a Vector Autoregressive framework for determining the existence of long run relationships. Augmented Dickey Fuller (ADF) test and Johansen co-integration technique have been adopted for stationary test and co-integration. The explanatory variables chosen are domestic and US equity market returns, historic volatility of both domestic and US equity market returns, expected volatility of both domestic and US equity markets and the rupee dollar exchange rate. The study has been done for different time phases of Indian stock market sentiment to identify whether the explanatory variables chosen differ in their explanation of FII net inflows, controlling for market sentiment.

Size and Liquidity Effects in Nigeria: An Industrial Sector Study

This study estimates liquidity premiums using the recently developed Liu (2006) measure within a multifactor capital asset pricing model (CAPM) including size premiums and a time varying parameter model for the West African emerging market of Nigeria. The evidence suggests that liquidity factors are relevant only for financial and basic materials sector stocks while size factor is more generally relevant in explaining the cross section of stock returns in the Nigerian domestic equity market. Costs of equity estimates are high further underlining the limitations of this market as a capital-raising venue in contrast to the dominant banking sector.

Determinants of Foreign Capital Flows: The Experience of Selected Sub-Saharan African Countries

This study investigates the major determinants of international capital flows in selected countries in Sub-Saharan Africa. Both theory and the empirical literature suggest that financial liberalization and regionalism lead to higher levels of capital inflows. By using a dynamic panel data analysis, this research tests these hypotheses. The impact of financial liberalization depends on the type of liberalization implemented. Liberalization of the domestic financial system and the domestic equity market has a positive and significant impact on international capital flows. Aggregate capital account liberalization is not significant, but the elimination of multiple exchange rates significantly affects international capital flows, while other components have a more limited impact: the liberalization of inward FDI directly increases foreign direct investments, whilst the deregulation of offshore borrowing directly causes an increase in foreign debt inflows. Regionalism causes an increase in foreign direct investment inflows but does not affect other forms of capital inflows.

Management of Flow Risk in Mutual Funds

This paper is the first to relate the investment practices of U.S. equity mutual funds to their management of flow risk, defined as the adverse effect of investor in- and outflows on fund performance. Using a comprehensive merged sample of 2,585 actively managed U.S. domestic equity funds from the CRSP mutual fund database and the SEC’s regulatory N-SAR filings, we are the first to detect differences in funds’ responses to flow risk. We find that funds using derivatives, such as options and futures on indices as well as individual stocks, have higher performance than non-using funds. We further show that this outperformance is the result of superior flow risk management using these derivatives and not a result of derivatives based stock-picking or market-timing activities. Overall, our findings document that superior flow management ability is valuable when managing open-end mutual funds and should be considered by investors and researches when evaluating fund performance.

On Market Timing, Stock Picking, and Managerial Skills of Mutual Fund Managers with Manipulation-Proof Performance Measure

The on-going debate over whether fund managers have skills and whether those skills are short-lived is still inconclusive. Using the performance measure that can’t be manipulated with respect to the underlying distribution, time variation, nor estimation error, (the manipulation-proof performance measure (MPPM, Goetzmann et al. (2007)), we rank all U.S. domestic equity mutual funds from 1980 to 2012 on a quarterly basis and analyze their portfolio holding to contribute to the literature in two folds. First, managers ranked highest on MPPM in the current quarter earn largest fee-adjusted fund returns in the following quarter. Those managers hold younger, smaller, lower book-to-market, and momentum stocks. Second, taking long positions of the addition and short positions of the removal from their quarterly holdings from the highest ranked managers would outperform the lowest ranked managers by 12 basis points at the following quarter. Even though higher ranked managers have better stock picking skills, their fund returns are not large enough to offset their frequent transactions and higher expenses to insure positive alphas.

Foreign Portfolio Investment Flows to India: Determinants and Analysis

Summary This paper analyzes the macroeconomic determinants of portfolio flows to India and finds that lower exchange rate volatility and greater risk diversification opportunities are conducive to portfolio flows. However, higher equity returns of other emerging markets discourage these flows. Other conventional determinants of portfolio flows are domestic equity performance, exchange rate, interest rate differential and domestic output growth. An analysis of disaggregated portfolio flows shows that determinants of FIIs are similar to aggregate portfolio flows, while ADR/GDRs are significantly influenced only by domestic equity returns, exchange rate, domestic output growth, and foreign output growth.

Inflation Hedging with International Equities

Existing research discards domestic equities as an inflation hedge, yet overlooks international equities. This article shows that international equities hedge against inflation levels and inflation changes more effectively than do domestic equities. The protection is stronger for country-specific inflation shocks and for weak domestic currencies. International equities thus protect investors who need it the most, but remain an insufficient hedge for investors in the most monetarily stable countries. The analysis is based on 24 advanced economies between 1971 and 2010. It tests broad domestic and international equity indices, as well as country portfolios based on inflation co-movement. Data on 21 emerging economies confirms these findings. <b>TOPICS:</b>Portfolio theory, financial crises and financial market history, in markets

The Dynamics of Institutional Investments and Stock Market Volatility: Evidence from FIIs and Domestic Mutual Funds Equity Investment in India

This study examines the dynamic interaction among institutional investment (FII and Mutual Funds) and the stock market returns for India in a three factor vector autoregression (VAR) framework. The data set used in this study are in daily frequency spanning from 1st Jan 2002 to 31st July 2012 and extracted from various sources such as PROWESS database of Center for Monitoring Indian Economy, the official website of Securities and Exchange Board of India (SEBI), Reserve Bank of India Official website and Bombay Stock Exchange. By considering the two types of flows (FIIs and mutual funds net equity investment) to be interdependent and hence form the endogenous part of the VAR system, we find that both mutual fund flows and the FII’s fund flows are significantly influences Indian stock market. It is evident that the BSE returns (with lags) are positively influencing FII’s flows but it turns to be negative in determining mutual fund investment flows during the study period. We observe similar kind of results after controlling for market fundamentals. The Granger causality analysis signifies a bi-directional causation between the institutional investment and stock market returns. The structural VAR impulse response analysis suggests that the response of Sensex return to both types of institutional investment flows are negligible or insignificant. However, the FII’s net investment is positively responding to stock return about up to 3 days, and it is negatively responding to the mutual fund flows. The response of mutual fund net flows to stock return is initially positive but it turns to be negative in the next two days. It responds negatively to the FII net flows.

Investors' expectations, management fees and the underperformance of mutual funds

Why do investors buy underperforming mutual funds? To address this issue, we develop a one-period principal-agent model with a representative investor and a fund manager in an asymmetric information framework. This model shows that the investor’s perception of the fund plays a key role in the fund’s fee-setting mechanism. Using a simple relation between fees and funds’ performance, empirical evidence suggests that most US domestic equity mutual funds have added high markups during the period from July 2003 to March 2007. For these fees to be justified, we show that the investor would have expected the fund manager to deliver an overall annual net excess-return of around 1.5% above the S&P500 on a risk adjusted basis. In addition, our model offers a new classification of funds, based on their ability to provide benefits to investors’ portfolios.

Petrodollars and Global Imbalances

As the world economy recovered and grew, the price of oil rose markedly, peaking at almost $70 per barrel in 2005 before ending the year at $61 per barrel. Today, the price continues to hover at around $65. This sustained rise in prices has generated hundreds of billions of dollars of extra revenue for oil exporting countries (e.g. the Bank of International Settlements estimates $1.3 trillion to OPEC since end-1998). This Occasional Paper examines the major sources and uses of this windfall and its impact on global imbalances. The paper is not intended to be a comprehensive assessment of the petrodollar phenomenon, but rather to identify issues that warrant further examination. Key findings of our analysis suggest that: From 2002 to 2005, oil exporters appear to be spending proceeds from the oil windfall relatively evenly on increased imports and reserve accumulation, but import spending and the percentage spent on imports will likely rise over time. Some oil exporters are responding to the windfall by increasing reserves, retiring debt, and setting aside money for future generations, measures which should help insulate them from oil price volatility. Many countries are also channeling financing to productive investments intended to support growth, in contrast to the last oil boom. However in some cases, domestic spending increases have included hefty public sector wage hikes. The complexity and integration of financial markets make it difficult to assess fully where the oil windfall is being invested, though it is clear that domestic equity markets, and, to a lesser extent, real estate markets in the Gulf, are benefiting. Oil producers’ current account surpluses have increased already large global imbalances. While inflation remains broadly contained in oil-exporting countries with pegged exchange rates, more flexible exchange rates would allow better control over domestic monetary conditions and promote efficient external adjustment.

Applied Optimization in Global Efficient Portfolio Construction Using Earning Forecasts

The authors analyze the performance of an optimal global portfolio constructed from a 10-factor stock selection model that includes earning forecasts. Under the Markowitz mean–variance framework, applied optimization techniques are used to address the practical issues of risk tolerance, turnover, and tracking error. The impact of these practical constraints on portfolio performance is analyzed through extensive numerical experiments. The analysis finds that, subject to the same set of practical constraints, the risk-adjusted return of the efficient portfolio of the global equity universe outperforms that of the domestic equity universe. Active portfolio return increases with investors’ risk tolerance and the systematic tracking error allowed against the benchmark portfolio. <b>TOPICS:</b>Portfolio construction, factor-based models, performance measurement